Law firm break-ups

Dissolving a law firm is a process, not an event, the D.C. Bar Legal Ethics Committee said in a new opinion released earlier this month, and some ethical obligations continue even after dissolution. “The paramount” principle, said the committee, is to “continue to competently, zealously and diligently represent and communicate with the clients during the dissolution process.”

Answering the three W’s

The opinion addresses the situation where the firm dissolves or will do so in the reasonably foreseeable future, and it answers many of the “who,” “what” and “when” questions that can arise. Here are some of them:

Who should get notice of the upcoming dissolution? All clients, even those with inactive matters and files that have been closed less than five years. If the firm is holding intrinsically valuable client property (wills, stock certificates), the client should be notified no matter how long the file has been closed. Relevant third parties, such as opposing counsel and tribunals, should also get notice.

Who should give the notice? Joint notice by all firm members is “preferred.” But if the firm’s lawyers cannot agree on the form or the terms of that notice, the lawyer with the most significant contact should give notice. Only if this is not practicable should lawyers give unilateral notice to the clients.

When should notice be issued? There is no bright line. Notice must be timely, and at least give time for the clients to make an informed decision about their future representation, to hire other counsel, and for papers and property to be returned (including any refunds owed).

What should be communicated? The notice can’t contain false or misleading statements, and should provide the clients with options: to choose representation by any member of the dissolving firm; by any other lawyer; or by any other firm. The notice may not restrict any lawyer’s right to practice, which is barred by D.C.’s adoption of Model Rule 5.6.

What if the client doesn’t respond? The notice should provide that if the client fails to respond by choosing one of the options, the client is deemed to remain a client of the lawyer who has been primarily responsible for providing legal services to the client. The D.C. Committee recognized that identifying that lawyer can be difficult; it did not deal with the issue of the potentially open-ended time-frame for the “responsible” lawyer’s duties to the unresponsive client, or what happens if the lawyer is headed to a firm where she would have a conflict in continuing to represent the unresponsive client.

What files must the firm return to the client? D.C. law permits lawyers to assert and enforce retaining liens for unpaid fees against client property — but they are “strongly disfavored” under a 1994 ethics opinion. Rather, even when asserting such a lien, the lawyer can retain only the lawyer’s own work that the client hasn’t paid for, and then only if the client can pay and if withholding that portion of the file will not irreparably harm the client’s interests. For files in electronic form, the lawyer must comply with a client’s reasonable request to convert electronic records to paper form, absent some agreement to the contrary. The client ordinarily must bear conversion costs.

Dissolving a firm that includes non-lawyers

Unique to D.C. practice is the issue of dissolving a firm that includes lawyers and non-lawyers in partnership — a form of practice permitted there under D.C. Rule 5.4(b). The rule permits lawyers to practice in firms where non-lawyers hold a financial interest or managerial authority, and carry out “professional services which assist the organization in providing legal services to clients.” Because the rule says that the non-lawyers in such a firm have the same ethical duties as the lawyers, the duties as to the dissolving firm would apply equally to the non-lawyer partners of such a firm, said the D.C. Committee.

A high-profile duel over rights to legal databases is playing out in state court in Boston. The warring parties are six former partners and the asbestos defense firm they left, allegedly taking with them high-value file-management and other databases. The firm’s suit, filed in November, raises the question: When partners leave, does a database that includes client information belong to the clients they take with them? Or to the old firm, which says it has invested heavily in developing the proprietary database?

Digital age departures

Model Rule 5.6(a), adopted by Massachusetts and most other jurisdictions, makes client choice the paramount concern when lawyers move from firm to firm, prohibiting any agreement that restricts the right of the migrating lawyers to practice. Model Rule 1.16 also protects a client’s right to their file when the representation terminates, thus limiting the right of the old firm to “lock up” the file, and protecting the right of the departing lawyers to take files and service clients at their new firm. And Massachusetts’ version of Rule 1.16 enlarges on that concept, with an expansive and detailed list of file items that “belong” to the client.

But where does a custom-developed digital database fall under an ethics rule analysis? Firms can invest heavily in developing such specialty management tools. Does the principle of client choice mean that departing lawyers can walk away with such a valuable asset and use it to service those clients in their new practice?

Database dispute

As reported in the ABA Journal, the Boston Globe and the Boston Business Journal, the Governo Law Firm asserts in a complaint filed in Suffolk County Superior Court that the six former partners had been negotiating to buy the firm. Included in the discussions were the databases, which Governo alleges it developed as a proprietary system, and which it says contains information about billing, expert witnesses, client correspondence, court rulings and asbestos litigation literature.

The Boston Business Journal describes the Governo firm as “a small firm that has built a national profile defending companies accused of exposing workers and consumers to asbestos.”

According to the complaint, before abruptly ending the sale discussions and leaving, one of the former partners had copies of the databases downloaded to her own computer. The six partners allegedly took more than half of Governo’s business with them; the complaint asserts claims for misappropriation of trade secrets, interference with contractual relationships and civil conspiracy.

The former partners opened their new firm on December 1, and are asserting that the database information belongs to the clients who came with them, and who were billed for the work connected to the databases.

On January 11, the Suffolk County Superior Court in Boston denied the Governo firm’s motion for preliminary injunction, ruling that the record was too undeveloped to determine whether the databases belong to the Governo firm, or to the clients who moved their business to the new firm. A scheduling conference is set for Feb. 14.

The Boston Globe reported that the case is being carefully watched, for its potential to make law on “leaving a law firm in the digital age.”

Watch your P’s and Q’s

In denying injunctive relief, the judge reportedly assessed evidence from both sides on the ownership of the database material, but found it insufficient to decide. That would appear to be a sound call, since determinations in this area can be very fact-specific. Key factors might be whether the firm used its own funds to develop the data base, or if those development costs were passed on to clients. In the latter case, an argument could be made that the clients charged for creation of the database should have a continuing right to have the lawyers use it at their new firm.

Whether you are a firm manager or a lawyer thinking about leaving your firm for greener pastures, this is an area where it pays to check your jurisdiction’s rules and ethics opinions before acting. As we’ve noted before, some states regulate the departure process by rule, and others have guidance on notice, client files and more, in their ethics opinions. The law also continues to develop on law partnership agreements that try to bring some certainty to this potentially contentious aspect of legal practice. We’ll continue to keep you posted.

The opening brief has been filed in a Fourth Circuit appeal that’s sure to be closely watched by the 100,000 members of the D.C. bar, as well as others. A key issue in Moskowitz v. Jacobson Holman PLLC is whether a law firm partnership agreement can reduce a partner’s equity payout if the partner walks out the door with clients. The district court said that the provision violates ethics rules, and is therefore unenforceable as against public policy.

Forfeiture and right to practice

Many law firms attempt to protect their interests with partnership or operating agreement provisions that penalize equity holders who take clients with them when they depart the firm. The validity of such provisions has been litigated elsewhere, with the same result as the district court’s ruling in Moskowitz. A notable example is Cohen v. Lord Day & Lord, the decision that also contributed to the New York Court of Appeals’ rejection of the “unfinished business” rule in 2014.

LordDay and its progeny have been generally decided under state versions of Model Rule 5.6 (and its predecessor, DR 2-108), which prohibits lawyers from making or offering an “operating … agreement that restricts the right of a lawyer to practice after termination of the relationship,” except for retirement provisions.

In opinions similar to Lord Day and the district court’s ruling in Moskowitz, courts have refused to enforce agreements that require forfeiture of earned compensation when a departing lawyer competes with the lawyer’s former firm. (There are many factual permutations to those holdings, however, and a number of jurisdictions reject any bright line approach.)

In Moskowitz, an amendment to the Jacobson firm’s operating agreement provided that a member who “withdraws from the Company … and takes client(s) of the Company” would forfeit 50 percent of the member’s equity interest that would otherwise be payable.

When Moskowitz left the firm in 2013, he apparently took the business of almost 50 prior clients (who paid more than $1 million in fees over the next two years). He sued the Jacobson firm in 2015, asserting that Rule 5.6(a) of the D.C. Rules of Professional Conduct barred enforcement of the amendment, a position that the trial court accepted.

Firm argues for “non-substantial” exception

On appeal to the Fourth Circuit, the Jacobson firm is advancing an interesting argument in favor of reversal.

Reducing the payout of an equity interest, it says, is not by itself sufficient to violate Rule 5.6. While the rule proscribes an agreement if it “restricts the rights of a lawyer to practice after termination of the relationship,” the firm says that comments to D.C. Rule 5.6 recognize that a financial penalty may not be prohibited if it is not “substantial.” In evaluating the substantiality of a forfeiture, it argues, the amount of the penalty should be compared to the lawyer’s post-withdrawal practice income at his or her new firm.

Using that measure, the firm says, Moskowitz’s penalty for competing against his former firm (about $63,000) is a small fraction of his annual earnings as a highly-compensated lawyer before and after he left Jacobson.

Firms in D.C. and elsewhere will be interested to see if the Fourth Circuit buys this approach.

Lawyers who leave a firm for greener pastures can present challenges, with the lawyer and the former firm each trying to position itself to take or keep clients.

While several states have ethics opinions with guidelines on managing the process, Virginia has now become the second jurisdiction in the country to add such guidelines to its actual ethics rules — in particular covering how and when lawyers and firms must give notice to the affected clients.

New Virginia Rule 5.8

The new Rule 5.8 of the Virginia Rules of Professional Conduct is significant in mandating that neitherthe firm nor the departing lawyer may unilaterally contact clients to inform them of the lawyer’s impending departure before at least attempting to negotiate a jointcommunication.

Only if the firm and the departing lawyer cannot agree on the form of a joint communication may they take unilateral action to inform the client and solicit the client’s choice to either remain with the firm, go with the departing lawyer or choose “none of the above.” In any event, notice to the client must be timely.

If the client does not express a choice, the new Virginia rule provides that by default, the client remains a client of the firm — at least until the client gives notice to the contrary.

Similar rules apply when a firm dissolves, except that a client of a dissolving firm who fails to express a choice remains a client of the lawyer who was primarily responsible for that client.

Florida rule on notifying clients of lawyer departures

Florida is the only other state to regulate lawyer departure notification by means of an ethics rule. Rule 4-5.8 of the Florida Rules of Professional Conduct provides that a departing lawyer may not unilaterally contact clients of the firm to notify them and solicit representation unless the lawyer has approached the firm and attempted to negotiate a joint communication. Only if bona fide negotiations are unsuccessful may the lawyer notify clients unilaterally.

Therefore, in contrast to Virginia’s Rule 5.8, Florida restricts only the departing lawyer from making a unilateral reach-out to clients. The law firm remains free to do so — clearly a disequilibrium between the respective rights of the departing lawyer and the firm.

Ethics opinions fill in state rule gaps

Many of the jurisdictions that do not address the subject of lawyer departure and client notification by rule do so in ethics opinions issued by state bar associations or other ethics regulators.

An advisory opinion of Ohio’s Board of Professional Conduct, for example, says that clients can be notified separately or jointly — but only after the lawyer has notified the firm of the lawyer’s intent to leave. In all events, an unseemly “client war” that degrades the profession should be avoided, the opinion says. Other opinions are from California and Pennsylvania.

Watch for more rules

Stay tuned: as the legal profession becomes increasingly regulated, more states will likely take the direction that Florida and Virginia have.

On Wednesday, the Second Circuit Court of Appeals put a nail in the coffin of the attempt by Thelen LLP’s bankruptcy trustee to claw back fees on work that the firm’s former partners took with them to their new firm, Seyfarth Shaw LLP. Here’s the opinion.

The Second Circuit ruling came after it asked the New York Court of Appeals to decide whether the trustee had a property interest in the fees, under the unfinished-business doctrine. The state court unanimously answered “No.” We posted on that ruling here.

In its brief opinion, the Second Circuit quoted the state court’s ruling, saying

Under New York law, the unfinished business doctrine does not apply to a dissolving law firm’s pending hourly fee matters, and … a partnership does not retain any property interest in outstanding hourly fee matters upon the firm’s dissolution.

The Second Circuit’s decision follows the California district court’s refusal last month to allow the administrator for the bankrupt Heller Ehrman firm to claw back profits from former partners. That ruling is on appeal to the Ninth Circuit Court of Appeals.

Seyfarth Shaw’s successful challenge to the unfinished-business doctrine in New York may be the beginning of the end of a line that began with the 1984 Jewel v. Boxer case, which first established the concept.

Thompson Hine was co-counsel with Seyfarth Shaw LLP in this case and in the New York Court of Appeals.

A new and perhaps final chapter has been written in the long-running saga of the 2008 collapse of the Thelen firm. The New York Court of Appeals has held that when lawyers exit defunct firms for greener pastures, the trustee of the old firm may not “claw back” profits earned on hourly-fee cases that those lawyers take with them to their new firms.

The ruling squarely rejects application of the “unfinished business doctrine” to law firms and lawyers. It comes on the heels of a California district court’s refusal to allow the administrator for the bankrupt Heller Ehrman firm to claw back profits from former partners. That ruling is on appeal to the Ninth Circuit.

The unfinished business doctrine comes from agency law, and provides that even after a partnership dissolves, profits on then-uncompleted contracts remain the property of the dissolved partnership.

In the well-known Jewel v. Boxer decision, the California state court of appeals in 1984 held that whether an engagement was hourly or based on a contingent fee, the estate of a dissolved law firm was entitled to recover the profits earned on cases that began at the firm, even when they were completed at a lawyer’s new firm.

The unfinished business doctrine led many firms to add “Jewel waivers” to their partnership agreements, in order to circumvent the rule. Disputes over such waivers and the application of the unfinished business doctrine were common, exemplified by the Thelen case and others.

Now, at least under New York law, the unfinished business doctrine will not apply when law firms break up, and attorney-client relationships will not be considered the dissolved firm’s property or be subject to claw-back from the firms where the dissolved firm’s former lawyers might land.

The court said:

Treating a dissolved firm’s pending hourly fee matters as partnership property … would have numerous perverse effects, and conflicts with basic principles that govern the attorney-client relationship under New York law and the Rules of Professional Conduct.

Under those principles, clients have an “unqualified right to terminate the attorney-client relationship at any time,” and are responsible only for paying their former lawyers for “completed services.” The court reaffirmed long-standing New York law that lawyers must be free to migrate to other firms without undue financial restrictions, and that preserving client choice means that clients must be free to follow their chosen lawyers to their new firms.

Watch for further developments in other jurisdictions; many have partnership law and ethics rules similar to the ones that the court considered in the Thelen case.

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